Inside Canada's hardening NAFTA strategy

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It was Canada's chance to play tough.

U.S. Commerce Secretary Wilbur Ross and Jared Kushner, President Donald Trump's son-in-law, pressed the Trudeau government behind closed doors last month to reverse a pricing decision on ultrafiltered milk that was pushing American dairy farmers out of the Canadian market. The pair wanted Ottawa to step in to placate the President, who had seized on the dispute to publicly blast Canada as a bad actor "taking advantage" of the United States.

But Canadian officials held firm, insisting they were not going to intervene in the dairy industry's price-setting system and make concessions before the renegotiation of the North American free-trade agreement had even started. The Americans backed off. (It didn't hurt that the 75 Wisconsin dairy farmers at the heart of Mr. Trump's outrage managed to find new markets for their milk.)

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But the episode, described by sources with knowledge of the situation, demonstrated to Ottawa that it can push back with Mr. Trump's White House. It built the Canadians' confidence to stand their ground as bilateral tensions escalate ahead of the NAFTA renegotiation.

Canada's growing willingness to fight back reached a new level this week, when Foreign Affairs Minister Chrystia Freeland threatened to jettison a multibillion-dollar deal to buy Super Hornet fighter jets as retaliation for a trade dispute involving Boeing, the manufacturer of the planes. The unprecedented move – tying a defence contract to a corporate dispute, and raising the spectre of a trade war – is certain to have engendered heated debate within the Canadian government, which is not accustomed to taking such tough measures.

It adds a hard edge to the country's previously conciliatory approach to dealing with Mr. Trump as the clock ticks down to a likely August start for NAFTA talks. Mr. Trump's newly minted United States Trade Representative, Robert Lighthizer, sent Congress a letter on Thursday giving 90 days' notification of the administration's intent to renegotiate the deal.

The highest levels of the Trudeau government are in daily contact, either by telephone or text message, with the top people in the Trump administration, insiders said. Mr. Trudeau's chief of staff, Katie Telford, is frequently in touch with Mr. Kushner, while principal secretary Gerald Butts speaks with Steve Bannon, Mr. Trump's chief strategist. Ms. Freeland talks regularly with Mr. Ross, and was in Washington this week to meet separately with him and Mr. Lighthizer. Both Mr. Trump's economic czar, Gary Cohn, and deputy national security adviser, Dina Powell, also speak with various people in the Trudeau government.

Trade lawyer Mark Warner said the threats to Boeing are part of a pattern of resistance from Ottawa. He cited the fact Ottawa allowed the dairy industry to make the price change that shut out American ultrafiltered milk, and Mr. Trudeau's letter to B.C. Premier Christy Clark agreeing to consider her request to block U.S. thermal-coal exports from the province's ports as retaliation for American duties on softwood lumber.

"It's beginning to add up to a pretty aggressive response. It's not a one-off; it's a pattern that's developing here," said Mr. Warner, who works in both Toronto and New York.

Mr. Warner said he's not convinced it's a wise approach, particularly with someone as unpredictable as Mr. Trump: "If you have a government job or you're tenured faculty, threatening a trade war sounds like a good idea. But not if you're working in the engine factory in Winnipeg or Montreal that supplies Boeing."

The Boeing dispute began when the American company accused Canadian competitor Bombardier of illegally "dumping" C Series jets in the United States because Bombardier has received subsidies from the federal and Quebec governments. The Department of Commerce opened an investigation, and could decide as early as July whether to slap tariffs on Bombardier.

Rather than let the dispute play out in the U.S. system, Canada hit back, warning it would "review" its plans to buy 18 fighter jets from Boeing, a contract that could be worth $12-billion between the cost of the planes and later maintenance. Following through on the threat would put a lot on the line: Not only would it broaden a single fight into a wider trade war, but it would unravel the Trudeau government's procurement plans and ripple through cross-border supply chains.

"I can't recall anything like this," in terms of the Canadian government tying military procurement to a trade dispute, said Matthew Kronby, partner in international trade and investment law at Bennett Jones in Toronto. "In the general context of this aggressive posture the U.S. has taken on bilateral trade … the government of Canada is sending a signal that trade is very much a two-way street and that they will protect the interests of Canadian business."

Canada's stand appeared to have rattled Boeing: Reuters, citing unnamed sources, said the company's military division is seeking talks with Ottawa to try to resolve the situation. The company would not confirm this. Boeing spokesman Daniel Curran emphasized the company's prominence and contribution to the Canadian economy. "Boeing has approximately 2,000 employees in Canada and billions in economic impact on the country," he wrote in an e-mail.

Bombardier spokesman Mike Nadolski said, "Given that Boeing has brought an unfounded case claiming the Canadian government's actions violated trade rules, the government's position is not at all surprising."

Besides the tough talk, Canada's strategy for the NAFTA negotiations largely consists of trying to divert them away from Mr. Trump's promised protectionism. At the same time, Ottawa will attempt to move the talks toward an update of NAFTA that would preserve the existing agreement but enhance it to make it more like the Trans-Pacific Partnership, the 12-country pact that Canada and Mexico agreed to but Mr. Trump pulled out of during his first week in office. That deal covered the digital economy, which NAFTA does not, and included stronger labour and environmental provisions.

If the talks stall and NAFTA simply remains as is, both Canada and Mexico would be fine with that result, too, sources in their governments have said.

Ottawa is also building a partnership with Mexico City. Earlier this year, Mexicans had been wary that Canada would abandon them and look to cut a bilateral deal with Mr. Trump. But relations have steadily warmed, with Canadian and Mexican officials in regular contact. Ms. Freeland speaks regularly with her counterpart, Luis Videgaray, as well as with Economy Minister Ildefonso Guajardo, and is set to meet with both in Mexico City next week. Meanwhile, David MacNaughton, Canadian ambassador to the United States, hunkered down last week at the Mexican embassy in Washington with Ambassador Geronimo Gutierrez.

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